How Much Is LLC Tax? A Look at Federal and State Taxes
Navigating LLC taxes? Learn how federal tax treatment and diverse state requirements shape your business's total tax burden.
A Limited Liability Company (LLC) is a business structure that provides its owners with liability protection, separating personal assets from business debts and obligations. Determining the tax obligations of an LLC is not straightforward, as the entity itself is not a tax classification by default. Instead, an LLC’s tax treatment is influenced by factors such as the number of owners and any elections made with tax authorities.
Default Federal Income Tax Treatment
For federal income tax purposes, the Internal Revenue Service (IRS) generally treats LLCs based on their ownership structure. A single-member LLC (SMLLC) is typically considered a “disregarded entity,” meaning it is not taxed separately from its owner. Its income and expenses are reported on the owner’s personal tax return, specifically on Schedule C (Form 1040), “Profit or Loss From Business.” The income is taxed at the individual owner’s income tax rate.
When an LLC has multiple owners, it is generally treated as a partnership by default for federal income tax purposes. This type of multi-member LLC (MMLLC) is also a “pass-through” entity. The LLC files an informational return, Form 1065, “U.S. Return of Partnership Income.”
Each member then receives a Schedule K-1, “Partner’s Share of Income, Deductions, Credits, etc.,” which details their share of the LLC’s profits or losses. These amounts are then reported on each member’s personal tax return (Form 1040). This pass-through taxation ensures that income is taxed only once, at the owner level, avoiding the double taxation that can occur with traditional corporations.
Self-Employment Tax Obligations
Owners of LLCs, particularly those treated as sole proprietorships or partnerships for federal income tax purposes, are considered self-employed. This means they are responsible for self-employment taxes, which fund Social Security and Medicare.
Self-employment tax is levied on the net earnings from self-employment. 92.35% of these net earnings are subject to the tax. The Social Security portion is 12.4% on earnings up to an annual limit, while the Medicare portion is 2.9% on all net earnings, without a limit. Self-employed individuals can deduct one-half of their self-employment tax as an adjustment to income on their personal tax return (Form 1040). This tax is calculated on Schedule SE (Form 1040), “Self-Employment Tax.”
State-Specific LLC Taxes and Fees
Beyond federal obligations, LLCs can face various taxes and fees at the state level. These state-specific charges vary widely. These fees are independent of federal income tax and can apply even if the business is not profitable.
Common state-level costs include annual report or registration fees, fixed charges to maintain an LLC’s good standing. Some states also impose franchise taxes for the privilege of doing business in that state. These can be fixed amounts, like California’s annual minimum franchise tax of $800, or calculated based on factors such as net worth or gross receipts. Other states may levy gross receipts taxes, imposed on a business’s total revenue regardless of profitability, such as Ohio’s Commercial Activity Tax or Texas’s margin tax. Some states may also impose an entity-level income tax on pass-through entities or offer an elective pass-through entity (PTE) tax.
Electing Different Federal Tax Classifications
An LLC has the flexibility to elect a federal tax classification different from its default, which can alter its tax responsibilities. One common election is to be taxed as an S corporation. This is achieved by filing Form 2553, “Election by a Small Business Corporation.”
Under S corporation status, income still passes through to the owners, similar to a partnership. However, owners who also work for the business can pay themselves a “reasonable salary” subject to payroll taxes. Remaining profits distributed to owners are generally not subject to self-employment tax, which can lead to tax savings. This election introduces additional compliance requirements, including payroll processing and filing a separate corporate tax return, Form 1120-S, “U.S. Income Tax Return for an S Corporation.”
Another option is for an LLC to elect to be taxed as a C corporation, by filing Form 8832, “Entity Classification Election.” In this scenario, the LLC itself becomes a separate taxable entity and pays corporate income tax on its profits using Form 1120, “U.S. Corporation Income Tax Return.” C corporation taxation involves “double taxation,” where profits are taxed at the corporate level and again when distributed to owners as dividends. While C corporations can benefit from potentially lower corporate tax rates on initial profits compared to individual rates, the double taxation of distributed earnings is a consideration.